Macro vs. Growth

Why isn’t there a rebirth of American entrepreneurship, especially when starting a firm is easier than ever?

Washington’s economic policy debate is stuck, not in partisan gridlock, but in the wrong economics textbook. Politicians and pundits are constantly talking about macroeconomics. What’s missing is growth economics.

Monetary policy is by definition macro, and the central actor is the Federal Reserve. Is a two-year commitment to a Fed funds rate of zero wise? Should there be a QE3 to boost investment? Interesting questions. But not growth questions. True, a strong and stable dollar is essential for a pro-growth climate. But keep in mind that the Fed’s dual mandate is maximum employment and price stability, not growth.

Fiscal policy, understood primarily as taxes and expenditures, is also macro centric, though it needn’t be. Congress and the president rely primarily on the most basic macro model of Keynesianism, known by the identity Y = C+I+G+NX. This national income identity is used to justify temporary, timely, and targeted increases in G (government spending) when there is a recessionary decline in C (consumption), I (investment), or NX (net exports).

Is a two-year commitment to a Fed funds rate of zero wise? Should there be a QE3 to boost investment? Interesting questions. But not growth questions.

Non-defense spending spiked to a decidedly not temporary 20 percent of GDP following passage of the 2009 “stimulus” bill—that’s alarming, but really not the point. Conservatives correctly argue that growth is driven by the free market, which is crowded out by expansive government. Liberals correctly argue that the rule of law, not anarchy, is the ultimate foundation for said markets. To be sure, economists at least as far back as Adam Smith pointed to a growth formula that includes “easy taxes,” but the tax rate argument has devolved into a stalemate over the size of government. Besides, all these talking points have been around for decades, repeated glibly inside the beltway while the ongoing scholarly study of growth remains something of an undiscovered country.

Just to take one example, where does the Office of Growth reside in the executive branch? Why aren’t they consulting with growth textbook authors such as David Weil, Daron Acemoglu, Robert Barro, Xavier Sala-i-Martin, or perhaps Oded Galor, the editor-in-chief of the Journal of Economic Growth? When I first visited the Treasury Department years ago, I learned that there is an assistant secretary for economic policy with two deputies, macro and micro. “What about growth?” I asked. “Oh, everyone works on growth,” I was told. Meaning, no one.

What is growth?

Macro, for better or worse, studies the business cycle. Its policy objective is stability, softening the troughs and peaks. In contrast, growth economics is all about the long-run trend line in output per capita, damn the noise of fluctuations. Official Washington today assumes what economists once did: that the rate of growth happens magically and exogenously, beyond our models and beyond our control. Two percent per year.

One fascinating observation by Harvard professor Michael Kremer is that human population has grown exponentially over the millennia. More recently, per capita income growth has been accelerating, too. Since 1820, U.S. income per capita has grown by an average annual rate that increases roughly one-tenth of a percent every decade. One wonders, have we peaked?

New programs like cash for clunkers and green jobs subsidies are championed in the name of macro stability, but come at the expense of growth. The clearest example in effect is the 99-week duration of jobless benefits, which is simultaneously a Keynesian cash pump and a work disincentive. Just ask Alan Krueger, President Obama’s new top economic adviser, who wrote in a 2002 paper in the Handbook of Public Economics that, “the main labor supply effect of UI [unemployment insurance] is to lengthen unemployment spells.” Meanwhile, Paul Krugman has been arguing for costly new regulations precisely because they are costly, which he says will push more “investment” dollars into aggregate demand even as they hinder productivity.

Official Washington today assumes what economists once did: that the rate of growth happens magically and exogenously, beyond our models and beyond our control.

As an accounting exercise, economists learned half a century ago that physical inputs (capital and labor) do not in themselves lead to growth. If America wants to improve the welfare of its citizens, innovation is the only game in town. Innovation includes technology, but also incentives, institutions, and other intangibles.

A 2009 paper by Stanford economists Paul Romer and Charles Jones summarized the state of growth economics. Two of the levers for growth policy (a meme worth replicating) are market scale and human capital. The United States could enhance its vast internal scale, but externally it is stagnant. Growth has stalled alongside the drought of free trade deals and the quagmire of immigration reform.

As for innovation, one wonders how the growth rate can accelerate if the number of entrepreneurs continues to dwindle. Kauffman Foundation research by my colleagues Robert Litan and E.J. Reedy find a worrying decline in the annual U.S. entrepreneurship rate from a steady half million startups per year from 1977-2007 to an unprecedented low of 400,000 in 2009.

Why isn’t there a rebirth of American entrepreneurship, especially when starting a firm in an Internet-enabled, LegalZoom-greased, knowledge economy is easier than ever? We can only guess. But it sure would be nice if this was the question our politicians were talking about.

Tim Kane is an economist with the Kauffman Foundation. His research on entrepreneurship was cited in the 2011 Economic Report of the President.